Did the trade today -- sold some GGG to buy some more FLIR. If you looked at it objectively, this is unlikely to be a good trade. I did it because I wanted to have more money in FLIR then I had in GGG and I didn't want to sell something else to buy more FLIR to make it bigger than GGG.
I am a huge believer in the growth potential of infrared imaging -- I expect them to keep growing at 20-30% in revenues and to see operating margins expand while producing lots of free cash flow. That's much faster than GGG -- the reason the trade may not work is that FLIR's PE is almost 2X GGG's so much of the faster growth in FLIR is embedded in the expectations of both stocks. I guess I hope its not the case -- that FLIR will grow even faster than many believe or if not faster then at a high rate for longer than most believe.
Been moving slowly with FLIR -- now finally around HALF my eventual position (I hope) which is around 4% -- similar in size to GOOG, CME, UEPS and TSRA. That's 2X most of my other positions such as TECH, FDS, MDT, ILMN, etc. I would love to own more of the others (ex. MDT) at the right prices but so far I have talked myself out of buying.
Friday, December 14, 2007
MCO
MCO was back below $38 for a time today -- it closed at $38.5. Been doing more thinking on the issues.
1994 -- the last year the company experienced a down revenue year is included in a slide on a presentation available at their website -- it shows a 9% compound annual growth rate in revenues from 1992 -- 1996. So that period includes the peak year of 93, a down year in 94, a rebound in 95 and more growth in 96. they don't provide specifics but they do provide a log based chart and it seems to me that in 95 they got close to 93 levels but didn't beat them and in 96 they went to new highs.
That translates to 2006 = 1992 with 2007 being the peak year followed by a decline in 2008 and rebound years in 2009 and 2010 so that they are at new levels of growth in 2010. If you follow these numbers and assume a similar 9% growth rate from 2006 to 2010, then revenues in 2010 are about $2.875 billion. That translates into EPS of roughly $3.25 to $3.50 in 2010. Assume a 20-22 PE on those numbers and the stock could be around $70 -- not bad vs. $38.50 today. That's only 2 years away (we are using 2008 EPS estimates for valuation purposes now so 2 years from now we will be looking at 2010 numbers) to double your money.
What is the downside?
a. business model changes because forced to abandon issuer pays model. Stock would get cut in half again because the business would shrink dramatically. low probability but 50% loss potential (guess).
b. litigation expenses and or potential losses if courts rule they don't just issue opinions but rather guarantees -- if they lose the court case see risk a. -- big loss because the business model would be broke. Higher expenses due to litigation is one thing -- it hurts but its not that big of a deal -- losing a case means potentially losing the franchise.
c. competition in structured products ratings due to loss of credibility -- this means somewhat lower margins -- say 40% instead of 50% and less revenue growth because they are sharing more with competitors. No idea on downside -- say 25%.
d. Growth in debt issuance world wide slows to the point that Moody's revenues are still flat with 07 numbers in 2010. The great deleveraging people talk about that would hurt their revenues. Its possible -- this is the highest probability risk, yet I still think its a low number. economic growth leads to growth in debt -- its that simple -- very highly correlated so either we end up with no GDP growth for awhile (next few years) or most developed economies change dramatically away from debt. This means a flat to down stock price -- probably somewhere in the mid 20's soon and maybe $40 in 2010.
So let's say the downside from thursday's close is 33% and the upside is somewhere between 50-150% over the next few years. Good chance I'm early to the story but that is why I will buy small to start. Will dip a toe and wait for more info -- most likely bad -- then buy more when the stock dips towards $30. That's my guess. Key for me is their franchise is in tact in my mind -- they will remain a toll keeper on the growth in debt. International markets will ensure that debt grows nicely.
1994 -- the last year the company experienced a down revenue year is included in a slide on a presentation available at their website -- it shows a 9% compound annual growth rate in revenues from 1992 -- 1996. So that period includes the peak year of 93, a down year in 94, a rebound in 95 and more growth in 96. they don't provide specifics but they do provide a log based chart and it seems to me that in 95 they got close to 93 levels but didn't beat them and in 96 they went to new highs.
That translates to 2006 = 1992 with 2007 being the peak year followed by a decline in 2008 and rebound years in 2009 and 2010 so that they are at new levels of growth in 2010. If you follow these numbers and assume a similar 9% growth rate from 2006 to 2010, then revenues in 2010 are about $2.875 billion. That translates into EPS of roughly $3.25 to $3.50 in 2010. Assume a 20-22 PE on those numbers and the stock could be around $70 -- not bad vs. $38.50 today. That's only 2 years away (we are using 2008 EPS estimates for valuation purposes now so 2 years from now we will be looking at 2010 numbers) to double your money.
What is the downside?
a. business model changes because forced to abandon issuer pays model. Stock would get cut in half again because the business would shrink dramatically. low probability but 50% loss potential (guess).
b. litigation expenses and or potential losses if courts rule they don't just issue opinions but rather guarantees -- if they lose the court case see risk a. -- big loss because the business model would be broke. Higher expenses due to litigation is one thing -- it hurts but its not that big of a deal -- losing a case means potentially losing the franchise.
c. competition in structured products ratings due to loss of credibility -- this means somewhat lower margins -- say 40% instead of 50% and less revenue growth because they are sharing more with competitors. No idea on downside -- say 25%.
d. Growth in debt issuance world wide slows to the point that Moody's revenues are still flat with 07 numbers in 2010. The great deleveraging people talk about that would hurt their revenues. Its possible -- this is the highest probability risk, yet I still think its a low number. economic growth leads to growth in debt -- its that simple -- very highly correlated so either we end up with no GDP growth for awhile (next few years) or most developed economies change dramatically away from debt. This means a flat to down stock price -- probably somewhere in the mid 20's soon and maybe $40 in 2010.
So let's say the downside from thursday's close is 33% and the upside is somewhere between 50-150% over the next few years. Good chance I'm early to the story but that is why I will buy small to start. Will dip a toe and wait for more info -- most likely bad -- then buy more when the stock dips towards $30. That's my guess. Key for me is their franchise is in tact in my mind -- they will remain a toll keeper on the growth in debt. International markets will ensure that debt grows nicely.
Wednesday, December 12, 2007
Federal Reserve cuts 25
Ouch -- with friends like the Fed who needs enemies huh? Obviously the market traders who were setting prices today were hoping for 50bps and I can't blame them. My home equity line and my financial stock exposure was hoping for 50bps too. Grand scheme of things no big deal. We were primed for a breather after the recent rally and so now we have gotten it. I suspect we will be higher from here -- if not Wednesday, then soon after.
Darn TECH -- up over $70 now!!!! had the chance to buy more around $63 and didn't because of other options that I am now wary of. ugh!!
FLIR -- a sell rating has led to some profit taking -- should have bought more today especially if I think the market will rally from here but I didn't -- always hoping for more of course. Still at the equivalent of $62 that it closed near today, its still trading at high 20's multiple -- not much room for error. Mr. Am Tech puts out a sell saying all the good news is in the stock. Quite likely right but he was just talking about 2008. Maybe some upside but most likely he is right. On the other hand is the stock already discounting the strong secular growth of the next 3-7 years? not as convinced -- think the upside is still huge over time.
MCF -- bought some yesterday -- got a lousy price but those are the breaks. I listened to a couple of their conference calls tonight and the story is very interesting -- the guy said something fascinating about their value add --- they just discovered a 600bcf (billion cubic feet) natural gas find in the gulf of mexico -- probably the largest find in 15 years yet the 3D seismic on the area had been done in 1993 -- hundreds had looked at the very same data and seen nothing but they looked at it and found a huge store of gas. they won't and can't repeat that level of success but they can find several 50bcf reservoirs, which will be quite additive to the company's value given its small size.
Anyway, I plan on buying some more -- they have a $850 or so million market cap but CEO thought they were worth over 1 billion back in april when that 600bcf find was only 430bcf -- here we are with better fundamentals and the stock STILL isn't at 1 billion. I wouldn't normally take a CEO's word on valuation but this story is a little different.
that's about it for now.
Darn TECH -- up over $70 now!!!! had the chance to buy more around $63 and didn't because of other options that I am now wary of. ugh!!
FLIR -- a sell rating has led to some profit taking -- should have bought more today especially if I think the market will rally from here but I didn't -- always hoping for more of course. Still at the equivalent of $62 that it closed near today, its still trading at high 20's multiple -- not much room for error. Mr. Am Tech puts out a sell saying all the good news is in the stock. Quite likely right but he was just talking about 2008. Maybe some upside but most likely he is right. On the other hand is the stock already discounting the strong secular growth of the next 3-7 years? not as convinced -- think the upside is still huge over time.
MCF -- bought some yesterday -- got a lousy price but those are the breaks. I listened to a couple of their conference calls tonight and the story is very interesting -- the guy said something fascinating about their value add --- they just discovered a 600bcf (billion cubic feet) natural gas find in the gulf of mexico -- probably the largest find in 15 years yet the 3D seismic on the area had been done in 1993 -- hundreds had looked at the very same data and seen nothing but they looked at it and found a huge store of gas. they won't and can't repeat that level of success but they can find several 50bcf reservoirs, which will be quite additive to the company's value given its small size.
Anyway, I plan on buying some more -- they have a $850 or so million market cap but CEO thought they were worth over 1 billion back in april when that 600bcf find was only 430bcf -- here we are with better fundamentals and the stock STILL isn't at 1 billion. I wouldn't normally take a CEO's word on valuation but this story is a little different.
that's about it for now.
Sunday, December 9, 2007
odds and ends
CME -- an analyst report recently included charts that showed compound growth rates of 25% or more for the volume traded of each of the major contracts that are traded on CME's exchange. This year the growth is even faster thanks to the higher volatility. I have expected $20 in 08 EPS for some time but now the stock is at 35x those estimates. either the stock will settle in here or the estimates are going to have to go higher. not sure what volume estimates people are assuming now but I don't think we are up to 25% volume growth yet. I will have to double check and report back.
MCF -- Contango Oil and Gas. Fascinating company. They determined that exploration is the point where most of the value is created in the natural gas industry so they outsource everything else and focus just on that. They partner with top geologists and others in the industry to carry out operations. They construct their contracts to provide the right incentives to encourage the best from people. They have taken a small amount of capital and created enormous amount of value from it in just several years -- say $60 mill to $850 mill in just 8 years. The beauty is that they are still small and the value is asset based rather than revenues and earnings so I think there are fewer limits to how big they can get. I am not an oil and gas value expert but I understand a good strategy and management team when I see one -- these people know how to add value and generate returns for shareholders. this is old -- from dec 06 but check this link out:
http://www.ft.com/cms/s/2/c3c77068-863d-11db-86d5-0000779e2340,dwp_uuid=d8e9ac2a-30dc-11da-ac1b-00000e2511c8.html
TSRA -- they just signed a license with Toshiba -- another feather in their cap. good news in terms of their ability to get the consumer business up and running.
For those of you inclined to buy large cap stocks -- I think CSCO is pretty attractive right here -- I expect once they report again the stock will be back into the 30's. No way they are struggling while the rest of tech is doing well. they are just too well positioned. If I somehow had lots of cash, I would add this one but for now I have MSFT, GOOG, plus FLIR, TSRA, UEPS and FDS. plenty of tech exposure already. I would gladly trade MSFT for CSCO but tax costs make that impossible.
MCF -- Contango Oil and Gas. Fascinating company. They determined that exploration is the point where most of the value is created in the natural gas industry so they outsource everything else and focus just on that. They partner with top geologists and others in the industry to carry out operations. They construct their contracts to provide the right incentives to encourage the best from people. They have taken a small amount of capital and created enormous amount of value from it in just several years -- say $60 mill to $850 mill in just 8 years. The beauty is that they are still small and the value is asset based rather than revenues and earnings so I think there are fewer limits to how big they can get. I am not an oil and gas value expert but I understand a good strategy and management team when I see one -- these people know how to add value and generate returns for shareholders. this is old -- from dec 06 but check this link out:
http://www.ft.com/cms/s/2/c3c77068-863d-11db-86d5-0000779e2340,dwp_uuid=d8e9ac2a-30dc-11da-ac1b-00000e2511c8.html
TSRA -- they just signed a license with Toshiba -- another feather in their cap. good news in terms of their ability to get the consumer business up and running.
For those of you inclined to buy large cap stocks -- I think CSCO is pretty attractive right here -- I expect once they report again the stock will be back into the 30's. No way they are struggling while the rest of tech is doing well. they are just too well positioned. If I somehow had lots of cash, I would add this one but for now I have MSFT, GOOG, plus FLIR, TSRA, UEPS and FDS. plenty of tech exposure already. I would gladly trade MSFT for CSCO but tax costs make that impossible.
Thumb Sucking can be painful!
Thumb sucking. That's what I have been doing rather than decided to buy or not a couple of stocks. Thought about FDS and TECH each near their recent lows at $60 and $63 but was debating other stocks (MCO and QGEN, LMNX, etc). Next thing you know FDS is $65 and TECH is $69 not to mention MCO has jumped over 10%. not huge moves but a lot for just a few days.
As a libertarian free market type, I find the government intervention plan to "save" the mortgage industry and consequently the financial industry morally offensive. Nothing like violating the sanctity of contract and the mortgage holder's property rights by deciding that adjustable rates won't rise. If the private parties involved choose to modify the terms that's ok because its their decision -- the government getting involved just distorts everything.
As an investor and employee in the financial industry, I like the idea of stability and an end to the snowballing effect of foreclosures. The question is whether this marks the end or just a pause in the decline -- i.e. are we around March/April of 2001 (pause) or October of 2002 (end).
If its the end, then paying up a bit for MCO or FDS or TECH isn't so bad but if this is just a pause then we need to show some patience.
One thing is for sure -- sentiment is very bad right now. Hedge fund exposure to stocks is low and a lot of stocks -- financials are oversold. That means the market is going up.
Met with a wall street strategist recently who made the case that investors are crowded into stocks in certain sectors -- those with high international exposure like energy, materials and industrials. Its all a play on the secular theme of china driving demand and setting prices for all kinds of materials and infrastructure products. China is likely to see a slowdown in 2008 or in 2009 (post olympics) due to the monetary policy that China has in place. A slowdown in China will coincide with a pickup in US growth thanks to the fed's cutting rates. He argued that financials and consumer discretionary would be the best performing areas. I can certainly see that happening but I would point out he is a secular bear on financials -- he merely sees a cyclical rebound next year in the midst of long term struggle.
He also argued that emerging markets stocks would pull back next year -- performance has been too good and too many are too complacent about it continuing. My asian fund managers -- Matthews agrees -- they are conservatively positioned in undervalued securities -- that is hurting performance on the upside but will protect capital on the downside. I think everything the strategist said is likely to happen -- not sure when but I suspect it gets started around May of next year -- just seems like that is when the market has made changes the last couple of years. Not sure what actions I am going to take in my portfolio.
If financials do well next year, I think FDS's multiple will expand again and I think the pressure on DFR could loosen but that's very little exposure for me relative to what I have in energy and asia. might need to take some profits in the asian funds. I think health care -- especially LH could do better next year if attention shifts back to the US and so that could help me too.
not a big fan of any consumer discretionary stocks --own none right now. MCO could be my financials play.
more later.
As a libertarian free market type, I find the government intervention plan to "save" the mortgage industry and consequently the financial industry morally offensive. Nothing like violating the sanctity of contract and the mortgage holder's property rights by deciding that adjustable rates won't rise. If the private parties involved choose to modify the terms that's ok because its their decision -- the government getting involved just distorts everything.
As an investor and employee in the financial industry, I like the idea of stability and an end to the snowballing effect of foreclosures. The question is whether this marks the end or just a pause in the decline -- i.e. are we around March/April of 2001 (pause) or October of 2002 (end).
If its the end, then paying up a bit for MCO or FDS or TECH isn't so bad but if this is just a pause then we need to show some patience.
One thing is for sure -- sentiment is very bad right now. Hedge fund exposure to stocks is low and a lot of stocks -- financials are oversold. That means the market is going up.
Met with a wall street strategist recently who made the case that investors are crowded into stocks in certain sectors -- those with high international exposure like energy, materials and industrials. Its all a play on the secular theme of china driving demand and setting prices for all kinds of materials and infrastructure products. China is likely to see a slowdown in 2008 or in 2009 (post olympics) due to the monetary policy that China has in place. A slowdown in China will coincide with a pickup in US growth thanks to the fed's cutting rates. He argued that financials and consumer discretionary would be the best performing areas. I can certainly see that happening but I would point out he is a secular bear on financials -- he merely sees a cyclical rebound next year in the midst of long term struggle.
He also argued that emerging markets stocks would pull back next year -- performance has been too good and too many are too complacent about it continuing. My asian fund managers -- Matthews agrees -- they are conservatively positioned in undervalued securities -- that is hurting performance on the upside but will protect capital on the downside. I think everything the strategist said is likely to happen -- not sure when but I suspect it gets started around May of next year -- just seems like that is when the market has made changes the last couple of years. Not sure what actions I am going to take in my portfolio.
If financials do well next year, I think FDS's multiple will expand again and I think the pressure on DFR could loosen but that's very little exposure for me relative to what I have in energy and asia. might need to take some profits in the asian funds. I think health care -- especially LH could do better next year if attention shifts back to the US and so that could help me too.
not a big fan of any consumer discretionary stocks --own none right now. MCO could be my financials play.
more later.
Wednesday, December 5, 2007
TECH, QGEN, LMNX
The other choice I have been thinking about is adding to TECH or buying a new position in either QGEN or LMNX or something else. TECH is a great story but its a stock that has struggled and given the valuation and the relatively slow growth rate (but very consistent) I'm not sure the sluggish stock price is going to change.
QGEN has been a stronger performer in a related field -- they sell sample prep technologies that help automate lab processes when dealing wth nucleic acids (DNA/RNA). QGEN is also branching out into molecular diagnostics or testing based on DNA type stuff. I looked at the huge debt and the large goodwill on the balance sheet of QGEN and decided no thanks -- I realize they are a good franchise but I'm just not willing to bet on them -- if their franchise is so great why do they need to go out and spend a huge amount on buying Digene as a transformational deal that might move them more into diagnostics but will also change them from many products to a big concentration is just one -- HPV testing (cervical cancer).
LMNX provides DNA and protein analysis tools that can handle multiple tests on a single sample. Their business model is to partner or license their tech to others including TECH and QGEN. They have 4700 boxes in the field and they earn revenues for the systems (wholesale price, which is marked up to customer by their partners), for the consummables used in testing and royalties on total sales by their partners. its been a decent story though its never panned out as well as expected. If that's all there was, I might be more interested but ILMN's new Bead Xpress device is a competing instrument -- I have heard demand for the Bead Xpress is pretty strong for a new product so I am wary of buying into a competitor in LMNX. Now the good news for LMNX is that they are selling 600-800 new boxes per year and so far ILMN has sold maybe 40-80 so it will take awhile for ILMN to catch up if they ever do.
Interesting part of LMNX story is these partners -- 50 deals so far with 32 partners actually selling equipment and generating revenues. But only 4 account for about 47% of revenues so the rest of the partnerships haven't gotten too far yet. It takes time to take LMNX's technology and use it to develop new tests and get them into customer hands and change scientist behavior. My understanding is these partners are going to introduce several new products next year, which should accelerate growth. Don't know for sure. LMNX is also developing their own tests and they have some due to be introduced next year so that is another source of growth for 2008 and beyond. need to do some more research before deciding on this one.
QGEN has been a stronger performer in a related field -- they sell sample prep technologies that help automate lab processes when dealing wth nucleic acids (DNA/RNA). QGEN is also branching out into molecular diagnostics or testing based on DNA type stuff. I looked at the huge debt and the large goodwill on the balance sheet of QGEN and decided no thanks -- I realize they are a good franchise but I'm just not willing to bet on them -- if their franchise is so great why do they need to go out and spend a huge amount on buying Digene as a transformational deal that might move them more into diagnostics but will also change them from many products to a big concentration is just one -- HPV testing (cervical cancer).
LMNX provides DNA and protein analysis tools that can handle multiple tests on a single sample. Their business model is to partner or license their tech to others including TECH and QGEN. They have 4700 boxes in the field and they earn revenues for the systems (wholesale price, which is marked up to customer by their partners), for the consummables used in testing and royalties on total sales by their partners. its been a decent story though its never panned out as well as expected. If that's all there was, I might be more interested but ILMN's new Bead Xpress device is a competing instrument -- I have heard demand for the Bead Xpress is pretty strong for a new product so I am wary of buying into a competitor in LMNX. Now the good news for LMNX is that they are selling 600-800 new boxes per year and so far ILMN has sold maybe 40-80 so it will take awhile for ILMN to catch up if they ever do.
Interesting part of LMNX story is these partners -- 50 deals so far with 32 partners actually selling equipment and generating revenues. But only 4 account for about 47% of revenues so the rest of the partnerships haven't gotten too far yet. It takes time to take LMNX's technology and use it to develop new tests and get them into customer hands and change scientist behavior. My understanding is these partners are going to introduce several new products next year, which should accelerate growth. Don't know for sure. LMNX is also developing their own tests and they have some due to be introduced next year so that is another source of growth for 2008 and beyond. need to do some more research before deciding on this one.
finally a new post
Well its almost been a week since the last post -- man that sucks. I keep hoping I will find the time but then too many other issues pop up.
Interesting times to say the least. My thumb sucking on BOOM has led that stock into the 60's last I checked -- nice move. Oh well. I also thumb sucked on FDS -- a stock I own and hoped to buy more of but kept waiting for a lower price then $60 -- today it was around $65. TECH is another stock I have been watching and waiting to buy more of -- a week ago it was in the $62-63 range but I still didn't buy and by the end of today it was near $67.
In the case of FDS and TECH there are 2 reasons why I held off buying more -- MCO and LMNX/QGEN.
MCO or Moody's is a great franchise -- they own a toll on the issuance of debt. The issuer pays a fee to have Moody's rate the debt and then publish their ratings for all to see for free -- interesting model. Most pick on them for conflicts of interest and everyone rails against their horrible ability to predict the future -- yet they are a valuable tool for fixed income investors just like I believe equity sell side research is a valuable tool for investors when used properly (unlike how they were used in 1999-2000). Anyway, MCO has 50% operating margins and no real capital requirements so the business has enormous returns on capital and thanks to the constant growth in debt throughout the world -- they have demonstrated consistent growth in revenues over the last 20 years (1994 the one exception). Right now the low end of estimates says next year they will earn around $2.10, which equates to an 17 or so PE using $36 price. That said, don't forget that estimates have been dropping and the idea the stock is cheap can only be based upon the idea that future earnings power is near these numbers -- take EPS down to $1.50 and the stock is expensive.
The stock is down 50% from its highs -- so right away my interest perks up because this HAS BEEN an incredible secular growth stock that is now at a half off sale. But that's just a starting point -- questions to be answered: what about lawsuits and all the other regulatory talk? what about conflicts of interest -- will business model change? Will there be any new competition or any other reason for margins to decline? What will growth be like in the future -- has there been well above normal growth that will need to normalize i.e. experience a slow period? At what point is the stock low enough to buy?
I would love to be able to talk to the sell side analysts at this point to find out what investors believe -- what are they asking about -- if they are questioning the franchise because of concerns about rating agencies conflicts and how their ratings have been wrong, then I want to buy with both hands. If they are dispassionately noting that debt issuance is likely to grow much slower for a few years and that 2008 will see sharp declines in structured products that will drag down estimates below $2, then I might nibble. If they remain too bullish because they refuse to give up on the wonderful story Moody's has been, then I want to stay away.
A reasonable case is that 2008 stinks but after that debt issuance picks up again and in 3-5 years the company is able to earn $2.7 to 3 bill in revenues, which translates into $1.3 to 1.5 bill in operating profit or about $3.40 in EPS assuming they continue to use their free cash flow to buyback stock. I could easily make the case that the stock will double from here in the next 3-5 years. I could also make the case that the stock will continue to fall into the 20's as issuance continues to drop and they face margin pressure -- this is an industry not used to competing on price but also not used to facing declining revenues either. I could make a best case and assume they reach more like $4 bill in revenues in 3-5 years. That could drive a stock price over $100 or a triple from here.
still thinking about this one but its not often someone holds a half off sale on a business with this kind of profitability. Still to circle back to my original point -- to me exposure to MCO is exposure to capital markets which FDS also provides in a certain way so I would rather not add to FDS AND buy MCO -- need to decide on MCO and if its a No then there is no reason not to add to FDS.
Interesting times to say the least. My thumb sucking on BOOM has led that stock into the 60's last I checked -- nice move. Oh well. I also thumb sucked on FDS -- a stock I own and hoped to buy more of but kept waiting for a lower price then $60 -- today it was around $65. TECH is another stock I have been watching and waiting to buy more of -- a week ago it was in the $62-63 range but I still didn't buy and by the end of today it was near $67.
In the case of FDS and TECH there are 2 reasons why I held off buying more -- MCO and LMNX/QGEN.
MCO or Moody's is a great franchise -- they own a toll on the issuance of debt. The issuer pays a fee to have Moody's rate the debt and then publish their ratings for all to see for free -- interesting model. Most pick on them for conflicts of interest and everyone rails against their horrible ability to predict the future -- yet they are a valuable tool for fixed income investors just like I believe equity sell side research is a valuable tool for investors when used properly (unlike how they were used in 1999-2000). Anyway, MCO has 50% operating margins and no real capital requirements so the business has enormous returns on capital and thanks to the constant growth in debt throughout the world -- they have demonstrated consistent growth in revenues over the last 20 years (1994 the one exception). Right now the low end of estimates says next year they will earn around $2.10, which equates to an 17 or so PE using $36 price. That said, don't forget that estimates have been dropping and the idea the stock is cheap can only be based upon the idea that future earnings power is near these numbers -- take EPS down to $1.50 and the stock is expensive.
The stock is down 50% from its highs -- so right away my interest perks up because this HAS BEEN an incredible secular growth stock that is now at a half off sale. But that's just a starting point -- questions to be answered: what about lawsuits and all the other regulatory talk? what about conflicts of interest -- will business model change? Will there be any new competition or any other reason for margins to decline? What will growth be like in the future -- has there been well above normal growth that will need to normalize i.e. experience a slow period? At what point is the stock low enough to buy?
I would love to be able to talk to the sell side analysts at this point to find out what investors believe -- what are they asking about -- if they are questioning the franchise because of concerns about rating agencies conflicts and how their ratings have been wrong, then I want to buy with both hands. If they are dispassionately noting that debt issuance is likely to grow much slower for a few years and that 2008 will see sharp declines in structured products that will drag down estimates below $2, then I might nibble. If they remain too bullish because they refuse to give up on the wonderful story Moody's has been, then I want to stay away.
A reasonable case is that 2008 stinks but after that debt issuance picks up again and in 3-5 years the company is able to earn $2.7 to 3 bill in revenues, which translates into $1.3 to 1.5 bill in operating profit or about $3.40 in EPS assuming they continue to use their free cash flow to buyback stock. I could easily make the case that the stock will double from here in the next 3-5 years. I could also make the case that the stock will continue to fall into the 20's as issuance continues to drop and they face margin pressure -- this is an industry not used to competing on price but also not used to facing declining revenues either. I could make a best case and assume they reach more like $4 bill in revenues in 3-5 years. That could drive a stock price over $100 or a triple from here.
still thinking about this one but its not often someone holds a half off sale on a business with this kind of profitability. Still to circle back to my original point -- to me exposure to MCO is exposure to capital markets which FDS also provides in a certain way so I would rather not add to FDS AND buy MCO -- need to decide on MCO and if its a No then there is no reason not to add to FDS.
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